Monday, June 30, 2008

The most recent indicator review found continuing market weakness and, once again, we've seen more of the same this past week. The adjusted Demand/Supply Index (top chart) finally hit the -30 level that has been typical of intermediate-term market lows over the past few years, which suggests a very oversold market. On the way to that level, however, we've seen an expansion in the number of NYSE, ASE, and NASDAQ stocks making fresh 65-day lows (middle chart) and a breakdown in the advance-decline line specific to NYSE common stocks (bottom chart; credit to Decision Point). The cumulative NYSE TICK, as well, has been making fresh lows, indicating that--thus far--lower prices have not been attracting the interest of institutional buyers.

My recent look at the market's technical strength found that the weakness has affected most of the major sectors. Only 17% of S&P 500 Index ($SPX) stocks are trading above their 50-day moving averages; that number is only 13% for NASDAQ 100 Index ($NDX) issues and 3% for Dow Industrials ($DJI) shares. Small caps have been stronger, with 22% of S&P 600 Index ($SML) stocks above their 50-day benchmarks.

Among NYSE common stocks, we had 24 stocks making 52-week new highs on Friday against 289 lows. That compares to over 300 new lows at the March bottom and over 700 at the January bottom. Large cap issues--particularly in the Dow--are much weaker now than at those two prior junctures, but we've seen some residual strength among small cap and midcap shares. For example, we had only 52 new annual lows among S&P 400 midcap stocks ($MID) and 65 among S&P 600 small caps. Both those numbers are well below their January and March peaks.

The bottom line is that we are at oversold levels that historically have led to intermediate-term bottoms, but we're not yet seeing signs of buyer interest in stocks. To the contrary, we've seen a steady weakening of the market indicators. As long as that's the case, it's been dangerous to try to catch the market's falling knives..

This is one of the weakest set of technical strength readings I've encountered; it's typical of markets in which all stocks and sectors--the good with the bad--are being punished. I will be publishing a review of market indicators here on the blog tomorrow; I'm also starting to keep track of stocks and themes *not* making new lows here with the broad market..

Saturday, June 28, 2008

As someone who works as a coach/psychologist with portfolio managers at hedge funds on a regular basis, I have the opportunity to see the business from several unique angles. I find that, for the most part, writings from trading coaches and psychologists don't capture much of my experience. Just as there is a large gap between what is written about successful trading techniques and the actual techniques employed by professional traders, there is a significant gap between what is written about the success of traders and how success actually manifests itself in settings such as hedge funds. Here are five lessons I've learned from coaching hedge fund traders/portfolio managers that differ from the common wisdom in the magazines, seminars, and books.

1) Success is Individualized - Many writers and coaches, understandably, promote particular models of success, emphasizing common features of successful traders. While I do think there is a common *process* to developing expertise, the notion that successful portfolio managers have a common set of personality features or trading approaches simply does not hold water in the real world. It's much more important that portfolio managers understand and operationalize what works for them than fit a preconceived model of success. What works in one set of strategies and markets may not in others; what works for one trader is not helpful for others;

2) The Game is Different - This should go without saying, but it is rarely acknowledged: portfolio management in the hedge fund context is a different process from trading in the prop firm or retail context. As the name suggests, much of the success of portfolio management comes from managing ideas and positions over time, with multiple ways of expressing and hedging each idea. Too, many of these ideas are relational (relative strength based), not directional, and cut across markets and asset classes. This requires different knowledge and skill sets than trading in and out of individual markets with a directional bias. In particular, I find that writers give short shrift to the knowledge component of portfolio management expertise.

3) The Environment Matters - Many writings on traders attribute success to individual trader characteristics (personality, mindset, etc) and give very little mention to the role of the environment in the success of portfolio managers. The research, platform, risk management, and managerial support of traders matter quite a bit--so much so that portfolio managers who are successful in one setting may fail at another despite employing similar strategies. How a portfolio manager is managed matters quite a bit, and this is poorly understood.

4) Success Starts at the Beginning - Even very large hedge funds and investment banks are surprisingly unscientific when it comes to the hiring process. Much of portfolio manager/trader success or failure simply comes from putting the wrong people into positions. Because a portfolio manager has made money over the last X years, does not necessarily mean that they'll make money in a different setting, in different market conditions, or in a different regime of money management. There is much to be said for the fit between portfolio manager and the hedge fund as a firm, yet the fit is often not well understood--even by the firms themselves.

It would be great if helping hedge fund managers succeed was as simple as keeping them unemotional, as many writings suggest. The reality of the work I do week in and week out is that success is far more a function of applying specific skill sets to specific market conditions and cultivating/maintaining unique ways of viewing market relationships that capture opportunity. One size fits all approaches to coaching are of very limited utility in the real world of money management. It's all about helping professionals utilize the experience, skills, and resources at their fingertips in ways that work for them.

Friday, June 27, 2008

My previous post took a look at the NYSE TICK during Wednesday's trend day to the downside. We saw consistent selling sentiment through the day, as the broad list of stocks traded on downticks--at their bid, rather than offer, prices.

If we take a look at the TICK measure specific to the Dow 30 Industrials ($TICKI in e-Signal), we see a similar pattern. As the day wore on, the Dow stocks increasingly traded on downticks.

Because the Dow stocks are among the most liquid blue chip stocks, they are common constituents of the baskets traded by program traders. For that reason, the Dow TICK offers a good reflection of program trading sentiment.

Good trend days will show consistent buying or selling sentiment across the session. The NYSE TICK captures short-term sentiment by providing frequent readings of whether the broad list of stocks are trading on upticks or downticks.

Yesterday's market, as shown in the chart above, showed consistent downticking among NYSE issues. By cumulating the NYSE TICK, much as an advance-decline line is calculated, we can catch intraday shifts in sentiment. There were no such shifts yesterday.

As long as you see a trending cumulative NYSE TICK, it pays to fade countertrend moves in the index.

Thursday, June 26, 2008

A reader recently asked me about a problem he was having with "the fear of missing". It appears that he front-runs his setups, getting into trades before he gets proper signals. This fear of missing opportunity has hurt his performance, as it has placed his capital at risk during periods of low opportunity.

At the very least, the fear of missing signals can result in poor execution. Instead of buying on pullbacks or selling on bounces, you chase the market higher or lower. The several ticks of retracement typically incurred add up to quite an opportunity cost over time.

I'll be addressing the fear of missing trading opportunities in detail in my new book. (One chapter will be devoted to the "ten most common problems" of trading psychology and how to deal with them using psychodynamic, cognitive, behavioral, and solution-focused coaching methods). For now, however, let me focus on one aspect of this fear: the fear of oneself.

Let's say you *do* miss a golden trading opportunity. What will happen? Fear is a response to perceived danger. Where's the danger? What's the threat?

Very, very often the consequence of a perceived missed opportunity is a bout of angry thinking turned inward. After missing the good trade, the trader launches into self-blaming and a beating up process that mixes guilt with self-directed hostility. "How could you be so stupid?" and "Look how much money you could have made!" are among the common self-recriminations.

It is in this context that the fear of missing is really a fear of one's own negative thinking process.

Let's face it: we *always* miss potential opportunity. If you don't hold trades overnight, you miss possible opportunity. If you don't trade your maximum size, you miss potential opportunity. The reasonable trader knows that it's not about taking every conceivable opportunity: that would be impossible. Rather, it's about limiting your risk, while taking advantage of the best opportunities.

But if the result of missing trades is going to be an avalanche of self-criticism, the danger is not financial risk, but the risk of feeling worse about yourself.

If you don't have a negative, self-critical thought process, there's nothing to fear in missing. We always miss the very top and bottom ticks; we always are away from the screen when something is happening. No, it's not about the markets. Most often, the fear of missing is the fear of dissing oneself. The links below, as well as the chapter on cognitive techniques from my Enhancing Trader Performance book, should be helpful in dealing with this problem.

Wednesday, June 25, 2008

My new book has a tentative cover, and the writing is now past the halfway mark. I'll be updating readers about the new material covered in the text through a dedicated website. That site will have quite a bit of material to supplement the book. Thanks for your continued interest!

* Weakness Across Sectors - Looking at the 40 stocks in my basket, chosen evenly from eight S&P 500 sectors, my technical strength measure (a quantitative measure of trending) finds 4 in uptrends, 3 neutral, and 33 in downtrends. In a different show of weakness, we had over 3000 stocks across the NYSE, NASDAQ, and ASE making new 20-day lows on Tuesday. This has only occurred 12 times since September, 2002; one week later, the S&P 500 Index was up 7 times, down 5, for an average gain of 1.02%, much higher than the .16% average five-day gain for the remainder of the sample.

* Seeking Quiet - I was interested to see Charles Kirk's posting on noise-canceling headphones. I use a Bose variety during some of my guided imagery sessions to tune out distractions and help cancel some of the internal noise. Reducing physical activity and tension while eliminating outside stimulation is part of the meditative discipline, and I find it useful for getting back to calm, focused states during the market day.

* Useful Wisdom - The value of admitting errors, the perils of taking big chances, and other nuggets of wisdom are part of the review at Abnormal Returns.

Tuesday, June 24, 2008

Here is an absolutely phenomenal resource from Henry Carstens that takes your average win size per trade and the standard deviation of your daily returns and generates, Monte Carlo style, plots of your forecasted P/L curves. If you play with the two parameters, you'll see how changes in your risk (variability of your returns) and reward (size of your average profits) affect your overall results over time.

Imagine a $100,000 portfolio that averages, over the course of two years (100 weeks) a return of 50 basis points (1/2% or $500) profit per week with 100 basis points (1%) average variability per week. That would be a high Sharpe ratio trader. In the top chart, we see what that gets you: a pretty smooth equity curve and a return of about 50% over those two years.

Now let's imagine the same scenario but with double the variability of returns (middle chart). Notice that the end result is slightly better, but our P/L curve is much less smooth. There is a meaningful drawdown, peak to trough, along the way that lasts for over half a year.

Finally, let's imagine that markets change and our edge is cut in half as the volatility of our returns is increased (bottom chart). Not only do we make much less money--about 22% over the two years--but the pattern of returns is quite lumpy.

All of this has real psychological implications. When markets become more volatile and when market patterns change, we can go from scenario 1 to 2 to 3 rather easily, with exactly the same skills sets we've always had. The reduced returns and choppier path of returns can prove frustrating, leading traders to change their trading and further complicate the problems. Imagine, for instance, if our excellent trader in scenario 2 became discouraged during the drawdown period and stopped trading. Much potential profit would be lost.

Try Henry's forecaster by generating multiple possible forecasts for exactly the same parameters. You'll see that chance alone will affect the paths of returns. A trader who understands that it's not just about returns, but risk-adjusted returns, can best adapt to these trading realities.

Monday, June 23, 2008

While the large cap indexes are testing their March lows, the banking (middle chart) and housing (bottom chart) sectors have blown through those levels to make bear market lows. It's difficult to imagine the Fed aggressively raising rates with these sectors on their heels; that outcome might just rival the fate of the dog who decided to chase something other than his tail (top)..

In the most recent indicator review, we looked at a number of signs of weakness, including an expanding number of stocks making fresh 65-day lows and weak money flows. This past week saw more of the same, as new lows once again expanded (top chart) and selling sentiment (NYSE cumulative TICK; bottom chart) continued its bearish trend. We're now testing March lows in the Dow Jones Industrial Average and nearing those lows in the S&P 500 Index. Interestingly, the S&P 600 small caps and S&P 400 midcaps are well off their March lows, as is the NASDAQ 100 index.

These divergences help to explain why we're not seeing as many stocks making fresh 52-week lows as we did in January or March. On Friday, for example, we had 27 NYSE common stocks register fresh 52-week highs, against 161 new lows. By comparison, we had over 300 new lows in March and over 700 in January. Homebuilders, financials, auto manufacturers, airlines: there are a number of very weak sectors making annual lows. When we look at such sectors as technology, consumer staples, consumer discretionaries, materials, and energy, however, we see no new lows.

To be sure, the market is weak. The advance-decline lines specific to NYSE common stocks and S&P 500 stocks are right at their March lows. We're seeing fresh bear lows in the A-D line specific to the Dow 30 Industrials. But the S&P 400 midcaps and S&P 600 small caps? The lines specific to those remain modestly above their 2008 lows. So while the market is weak, it is not clear to me that it is weakening relative to the first quarter of the year. As long as selling sentiment (cumulative NYSE TICK) remains negative, riding the trend continues to be the best course of action. I'm not aggressively chasing the downside here, however, and may indeed nibble at the long side should sentiment improve..

Sunday, June 22, 2008

How you've been faring this year so far in the stock market is very much a function of the sectors you've been invested in. While the S&P 500 Index (SPY) has been down about 10% thus far in 2008, the commodities-related materials (XLB) and energy (XLE) sectors are up on the year. Financial stocks (XLF), on the other hand, have more than doubled the losses in the overall index and health care (XLV), facing calls for reform from both parties in a presidential election year, is also trailing the pack. Meanwhile, consumer staples shares (XLP) have shown a more modest decline than more growth-oriented sectors, reflecting investors' overall defensive stance in a slowing economy..

The trading of options on equities rather than the equities themselves has become increasingly popular among retail and prop traders. This makes the equity option volumes particularly relevant as market sentiment measures.

We can see from the chart above that spikes in equity put volume have accompanied recent intermediate-term market lows. With the latest pullback in prices in the S&P 500 Index (SPY; blue line), we can see that the four-day moving average of put volume (pink line) is once again spiking. While this doesn't mean we can't trade lower, it has recently been associated with price reversals over the intermediate term.

Saturday, June 21, 2008

In my last post, I illustrated the global bear market across the U.S., Asia, and Europe via country-specific ETFs. A number of readers pointed out that some countries are up on the year, and that is correct.

In the graph above, I plotted year-to-date returns for the U.S. (SPY); Australia (EWA); Canada (EWC); Russia (RSX); South Africa (EZA); and Brazil (EWZ). I included these countries alongside the U.S. to illustrate the more favorable performance among resource-rich economies. The exception is South Africa which has seen a weak currency, power shortages, and social unrest over the past year.

As oil producers, Canada, Russia, and Brazil have performed positively, even as large oil consumers, such as China, have been relatively weak. Since mid-May, however, with some toppiness in oil prices and intimations of greater supply from the Saudis, even the stock markets of the oil producers have undergone a correction..

While a great deal of attention has focused on U.S. stock market weakness (SPY), we're seeing just as much weakness among European equities, including the U.K. (EWU) and Germany (EWG). China (FXI) is leading the downside with Hong Kong, as inflation forces significant monetary tightening and a soft landing doesn't seem in the cards. Australia (EWA), a resource producer, has been relatively stronger, but the surprise in the bunch is Japan (EWJ), which has held up surprisingly well through the spike in energy and agricultural commodities and the weakness across Asia.

Friday, June 20, 2008

* Minor Milestone - TraderFeed recently recorded its 1,500,000th visit; thanks again for the interest and support.

* Great Resource Collection - Check out the back issues of the Breakout Bulletin from Michael Bryant. If you subscribe (free), you'll get the latest article on volatility-based exits. Mike is a systems developer with some excellent ideas.

* Congrats - To 10Q Detective's David Phillips for getting banned from message boards. Such is the welcome given to a financial blogger and journalist who digs beneath the surface and offers unique perspectives on stocks and companies. Great site.

* Measuring Trend - The Trade by Trend blog looks at how to measure a trend. Personally, I like regression lines and goodness of fit measures. That gives you slope and directional consistency. I like how the Trade by Trend site puts their trade ideas out there for readers.

Thursday, June 19, 2008

If you click on the bottom chart, you'll see a five-minute chart of the NYSE TICK for Wednesday, with a 10-bar moving average superimposed in blue. Note that the scale for the raw TICK values appears at right, but the scale for the moving average is constructed at left. That enables you to see peaks and valleys in the moving average quite well. It also helps us see how these peaks and valleys line up with relative highs and lows in the S&P 500 contract (top chart).

In a rising trend, we'll see successive peaks in the moving average of the TICK correspond to higher price highs in the index over time. In a falling market, we'll see lower price lows with each fresh valley in the TICK. In range markets, we'll see new peaks and valleys in the moving average of the TICK fail to bring either new price highs or lows.

Recall that the TICK is measuring the number of NYSE stocks trading on upticks minus the number trading at on downticks. This captures the short-term sentiment of traders, as they either aggressively lift offers across stocks or hit bids. A moving average of TICK thus can be thought of as a kind of overbought/oversold index of sentiment. Some of the best selling opportunities occur at TICK moving average peaks that fail to make fresh price highs; some of the best buying opportunities occur at TICK moving average valleys that cannot generate new price lows.

This style of trading has you executing in a countertrend fashion, but aligning the trade with a longer-term trend. I have found such an approach to be very useful, particularly in guiding execution.

Finally, notice that the moving average of the TICK spent most of the day below the zero (pink) line. That tells us that selling sentiment dominated through the day. By observing whether the moving average is spending more time above or below the zero line (and seeing how that is impacting price), we can gain tremendous insight into the supply/demand dynamics of the market as they unfold.

With frequent observation, you can become quite adept at filtering the market's behavior through the lens of the TICK. It provides a rare window on the actual buying and selling decisions of traders across the entire stock market.

Wednesday, June 18, 2008

As I mentioned in a recent Twitter posting, I've been receiving an unusually large amount of email of late. With the demands of going on the road to work with traders (you can see from the time stamps of my recent posts when I've had free time for the blog and Twitter), it's been very difficult to keep up with the mail.

To put this in perspective, if we just assume that 1% of readers email me each day and that each mailing requires just a few minutes for reading and response, I'd be spending the better part of two hours a day answering mail. That estimate is not far from the mark, particularly if I include mail from other sources, including traders I work with (who require lengthier responses) and idiots with their breathless offers of advertising, free services, additional site traffic, link exchanges, and the like.

So, to get the new book written and bring a modicum of sanity to life (not to mention find time to actually trade these markets!), I'll be cutting way back on emailing. Please don't be offended if I'm limited in my ability to respond to requests for coaching advice, introductions to trading firms, indicators/trading systems, and similar topics that are more than requests for information or clarification. It's not out of lack of interest or concern; it is simply a function of my limitations, given the work I do, my family obligations, the blog, and the book I'm writing.

As a rule, if the email runs for more than a paragraph, it's probably requiring a level of response that won't be possible for me. On the other hand, I'm only too happy to answer questions about posts, share links/ideas, and point readers in useful directions to get help.

An excellent slide show presentation from Jason Zweig, entitled Money and the Mind, illustrates how trading and investment decisions are colored by events in the body. An interesting quote that he draws from cognitive neuroscientist Antonio Damasio is:

"We make judgments not only by assessing probabilities and consequences, but also (and primarily) by evaluating their emotional attributes."

This is related to Damasio's "somatic marker" hypothesis: that we judge right and wrong, good and bad, from emotional consequences, and we associate certain bodily states with these consequences. When I decide to not eat a food that is bad for me, it's not a purely abstract, reasoned judgment. Rather, the decision is suffused with a physical sense of dislike when I am emotionally connected to the consequences of the eating.

These somatic markers help to explain the (literal) feel that traders can develop for markets after long exposure to patterns of supply and demand. The decision to buy or sell is suffused with physical cues associated with loss and gain: those somatic markers cue our decisions and actions.

We commonly think of opportunity as a function of market variables: volume, volatility, trending, and the like. But what if opportunity is more a function of one's access to his or her somatic markers? Might this be why traders so commonly view emotion as the enemy of good trading: the "noise" from overconfidence, fear, or greed drowns out the more subtle markers that alert us to risk/danger and reward/opportunity.

If we cultivated skills (self hypnosis, meditation) to still the flow of thought and emotion, would traders who had internalized market patterns display a superior access to their implicit learning and enhance their performance? This is a most promising area of investigation.

Tuesday, June 17, 2008

* Some Trends Aren't Friends - Going back to January, 1996 (N = 643 trading weeks), I compared returns when stocks (S&P 500 Index; SPY) were up on a one and four week basis and when they were down over the last week and four weeks. When stocks had been strong over those two periods, the next four weeks in SPY averaged a gain of only .05% (140 up, 119 down). When they were down over both those periods, the next four weeks in SPY averaged a gain of 1.01% (109 up, 68 down).* Frontier ETF - ETF Trends notes a very interesting product from Claymore that tracks frontier markets: the markets that will be tomorrow's emerging markets.

Across the NYSE, NASDAQ, and ASE, new 65-day lows continued to expand this past week (top chart), far outnumbering new highs. For three consecutive days, we registered over 2000 20-day lows, a situation that, since 2004, has tended to lead to a market bounce over the following week. Among just the common stocks listed on the NYSE, we hit 150 new 52-week lows at last week's nadir, which is significant weakening over the prior week, but not nearly as weak as the readings in January and March. This pattern of expanding new 52-week lows was evident among the S&P 600 small caps as well and, to a lesser degree, among the S&P 400 midcaps (which have been the strongest group of the three during the post-March rally).

With the selling, as noted in a recent Twitter comment, we've neared oversold levels (bottom chart) in the cumulative Demand/Supply index which have recently marked intermediate-term market lows, and we've hit levels from which the market has typically shown positive returns over the next month. Still, we'll need to see more sustained strength in the new high/low numbers and the money flows to get excited about the upside.

The market weakness has extended to most stock sectors. After dipping a bit below 30% during the week, the percentage of S&P 500 issues trading above their 50-day moving averages closed at 47% on Friday. That's down from 80% at the market high. The Friday percentages for small caps and midcaps respectively are 51% and 55%. Once again, we see considerable variation among the sectors: as of Friday, only 28% of S&P 500 financial issues are trading above their 50-day averages and 37% of consumer discretionary stocks, but 83% of energy stocks and 59% of technology shares are above their benchmarks.

Later this week, I'll devote a separate post to the Cumulative NYSE TICK, which has been making consistent new lows through the week, validating what we're seeing in money flows. Until we see greater evidence of demand for stocks, it will be difficult to sustain a bull move. That having been said, I'm not yet seeing the kind of selling that typified the markets in the first quarter of this year. As long as that's the case, we appear to be trading in a broad range defined by the March lows and the recent market highs..

Sunday, June 15, 2008

* Money Flowing Out of Stocks - The above chart shows how negative money flows (pink line) have been within the Dow 30 industrial stocks (blue line) since the start of May. The waning of negative flows was one factor alerting me to the March lows; the drying up of buying at the April/early May highs was a nice tell for the subsequent market weakness.

* Interesting Flow Observation - Some of the most negative money flows within the Dow universe over the last two weeks has been in XOM, a bit of a surprise given strength in oil prices. When we examine the price action in XOM, however, it's clear that it has underperformed oil overall. The money flows are so negative that they have me questioning the stock's prospects.

* A Look at the New Book - This post summarizes a few of the unique features of the coaching book I'm currently writing. What makes this interesting is that the structure, as well as content, of the text will be quite different from my other material.

It's difficult for me to balance what we know about the major theme of government fiscal irresponsibility with short to medium term trends. As you've mentioned, it's one thing to be a successful trader, producing income and another to be financially successful and responsible over the long term. A trader should be able to produce income but what of retirement and all those baby boomers that are going to pull their stock investments at the same time and start looking for income streams? With inflation including public monetization of bad bank loans (private debt) where can you go to get a hedge and protect assets for the future?

That's really the challenge of the investor, as opposed to the short-term trader: to, as best as possible, identify scenarios for the future, position oneself to profit from those (or at least to not lose money), and to be sufficiently hedged in the event one is wrong. Many times this will mean acting on scenarios that differ from what you see in the short-to-medium term, which--as Tim notes--can be difficult to balance.

A poor person is one who worries about how to pay the bills. A middle income person is one who worries about funding retirement. A wealthy person is one who worries about leaving enough for the next generation. More assets do not necessarily bring fewer worries, only different ones. When you don't have money, you are worried about making it; when you have excess capital, you're concerned about keeping it.

"Hope for the best, plan for the worst" is advice that has served me well as a short-term trader. By placing your stop-out level, you plan for the worst outcome and ensure you can survive it. Similarly, through diversification and hedges you can plan for the worst as an investor and balance your various risk exposures.

In the last year I've traveled in the U.S. from Miami, FL to Bellevue, WA and quite a few places in between. The common element has been cranes on the skyline. Building continues apace, even amidst indications of a housing oversupply. New luxury developments line the major Naperville street that passes our neighborhood; the houses are not moving, but more are being built.

In one area I visited recently, an entire condominium complex is going under. The developer could not sell enough units and thus could not raise sufficient association fees to properly maintain the development. This led to higher fees for existing tenants and cutbacks in services, including lighting in hallways. Caught in a death spiral, current residents find they cannot sell their properties for even bargain-basement prices: no one wants the liability of paying fees for a deteriorating facility.

Suppose the housing crises winds up much deeper and broader than expected. How would this affect the economy? How would this affect the income of municipalities and their ability to pay off debts? How would this impact banks holding mortgage debt--and how would that affect monetary policy at a Fed fearful of disintermediation?

It's not difficult to imagine a perfect storm for baby boomer retirees, in which interest rates kept low by an accommodative Fed restrain savings income, even as residential and stock market holdings are falling in value and employment opportunities (along with the economy) are contracting.

For those concerned about retirement and estate planning, the issue is not so much the specific odds that this scenario will unfold, but rather how one would stay in the game *if* it unfolds. For those distant from their financial goals, the temptation is to become aggressive and jump in to buy housing bargains, battered financial stocks, and juicy high-yield debt. I remember, too, when plenty of investors jumped in to buy bruised technology shares after their big drop early in 2000. They seemed like bargains when they were 25% off their highs...but wound up more like 75% off their highs over the next two years.

I believe Tim is asking the right question about finding hedges. The tricky part here is identifying whether the ultimate threat is inflation (and soaring interest rates and commodity prices) or deflation (and collapsing rates and financial asset values). For me personally, it's the prospect of a housing collapse, attendant bank crises, and an irresistible push toward quantitative easing at a Fed dominated by appointees from the next administration that leads me to seek protection from a possible perfect storm. As a result, locking in high quality yields and hedging against stock market and dollar weakness has been a dominant part of my increasingly fluid financial planning..

Saturday, June 14, 2008

March represented an important low in the major stock market averages, but it also was the occasion for several transitions in intermarket themes. With Fed easing, two-year Treasury yields fell much more rapidly than ten-year yields (top chart), but this changed in March. Now, with traders and investors anticipating Fed tightening due to inflation concerns and the need to support the dollar, two-year yields have been rising more rapidly than ten-year yields.

Concomitantly, we saw a massive rally in gold and a dramatic fall of the dollar going into March (bottom chart), but since then there's been a bounce in the dollar and a retracement in gold. The shift toward firmer yields has modestly supported the dollar, reducing gold's luster as a currency substitute.

March represented the start of a potentially important shift in monetary policy. That promises to continue to impact a number of asset classes, including--as we've seen lately--stocks, which view rising rates with some apprehension, given current economic weakness and continued weakness in the housing market..

With such interest rate differentials and a reluctance to cut rates overseas in the face of rising commodity prices and consumer inflation, continued U.S. dollar strength will likely depend upon continued upward pressure in Treasury yields, which hardly favors interest-rate sensitive sectors of the U.S., including housing..

Thursday, June 12, 2008

"I am having a good year trading but today marks the THIRD TIME this year that I've made a critical error which goes against my whole philosophy of trading.

I am a trend trader. That is how I make very consistent gains regardless of what the market is doing...I was buying a stock at levels where I believed it would bounce...of course the stock didn't bounce so I added more at lower levels and more even lower...

I got out of the trade on a rally, but it cost me the next two weeks of average profits...

I knew it was stupid when I was doing it, yet I continued to compound the problem. I didn't necessarily want to be right and make money on the trade, just minimize the losses (by buying more at lower levels)...

What I am not comfortable with is WHY I engaged in such risky behavior...what is the root, how do I find it, eradicate it?...The other two times were similar trades with similar results."

This is a very typical scenario that I help traders with. In this post, I'll walk you through how I view such problems and what I typically recommend.

The framework that I operate from, broadly speaking, is one that is known as brief therapy. These short-term approaches accelerate cognitive, emotional, and behavioral change by emphasizing hands-on skills building and the creation of powerful, new experiences that change how we view things.

Brief therapy is not appropriate for all people and situations, particularly those with chronic (longstanding) emotional problems that significantly interfere with areas of life functioning. Fortunately I know my writer and can vouch for the fact that he does not suffer from any significant emotional disorders.

So what is the key to his problem? What one feature stands out in his presentation? Take a moment and look over his words. What most strikes you about the difficulty?

One such key is that this has happened before in very similar ways. That tells us that it is likely a cyclical problem. Something initiates the pattern (sets it off); something keeps it going (even though he knows it is "stupid"); and something later kicks in to get him out of the pattern.

Most cyclical patterns are there for a reason: they serve a function. The trader's intense desire to find the problem and "eradicate" it is probably part of the problem pattern itself--much as the desire to eradicate insomnia can keep a person awake all night or the desire to eradicate fat can lead a bulimic person to binge eat.

In short, fighting the pattern is a mistake. The challenge is to understand the function of the pattern and then rehearse a different way of satisfying this function. Instead of viewing the problem pattern as maladaptive, the brief therapist views it as a form of problem solving that no longer works for the individual.

Let's take a simple example: Bill grew up with a mother that was anxious and overbearing. Conflicts at home were very unpleasant, so Bill learned to avoid conflict by minimizing communication with his mother whenever she sounded upset. This worked well throughout his childhood. Now Bill is married to Susan, who at times feels overwhelmed at work and reaches out to Bill. Much to Susan's dismay, Bill withdraws at those times and fails to offer support. She feels as though he doesn't care about what she's going through. Bill feels guilty about not being there for Susan and tries to make it up to her, only to fall short the next time she is worried or frustrated.

One might imagine Bill saying the same thing as our trader: "This is the THIRD TIME I've let my wife down...I know it's stupid when I'm pulling away from her, but I continue to compound the problem." It's a cyclical problem that represents a past, overlearned response to a stressful situation.

So how do we help Bill? We don't try to "eradicate" the problem--that hasn't worked. Rather, we get him to *talk* with Susan when he's feeling uncomfortable with her emotions. Step by step, we coach him through such a conversation, opening up about his thoughts and fears instead of pulling away. For example, we teach him to say to himself, "I'm not really uncomfortable with Susan; this is my old fear of my mother cropping up again. How can I tell Susan about that?"

As it turns out, just about anything Bill says to Susan in the situation about his experience will be helpful, because it will disrupt the old pattern and show her that he truly is listening, that he really cares. That sets the stage for the two of them to develop new patterns. Instead of trying to eradicate and bury his feelings, we use them as an opportunity for Bill to connect with Susan.

So back to our trader. He has a cyclical pattern in which he adds to losing trades, eventually taking outsized losers. This is frustrating to him (note the all-caps when he describes the THIRD TIME he's experienced the problem this year), and it is something he wants to get rid of. But what is the function of the pattern? Our trader perceptively notes it himself: "I didn't necessarily want to be right and make money on the trade, just minimize losses." So there it is: our trader is trying to avoid loss by averaging down. This is his way of fighting against failure, falling short.

In a subsequent communication, the trader revealed to me, "Each of these bigger losses occured after a period of very good trading. I didn't feel cocky, but my actions were. I cannot increase my relative risk tolerance after a period of success." This is a very good observation. The problem pattern is NOT triggered by a losing trade. It is triggered by success! After a winning period, our trader becomes emotionally attached to winning: he wants to eradicate losses. This has him resisting taking normal losses at his stop points and instead averaging down to minimize the loss. It's not that he's trying for a home run trade: he doesn't want to stop winning.

So there's the trap. Once the trader hits a winning streak, he wants to keep winning. This makes even normal losses feel threatening. So what can he do? Ironically, the answer is to purposely engage in guided imagery exercises before the trading day starts in which he mentally rehearses honoring his stop levels and taking normal losses. These exercises would be doubled following winning trading days. Just as we had Bill talk with Susan about his discomfort, we encourage our trader to openly confront his need to keep winning. Fighting the pattern hasn't worked; by facing the problem head on, he can keep a level head even when he's in his best winning streak.

I don't know our trader very well, but my guess is that there's more to his drive and desire for success. Perhaps he's *needing* to win instead of passionately *wanting* to win. There's an important difference. Once we're in the "need-to-win" mindset, losses become threatening and we try to avoid them by doing "stupid" things. By rehearsing an "ok to lose" mindset, we interrupt the need pattern and set the stage for initiating new patterns of trading well.

I enjoy trading and I find markets endlessly fascinating. But it's working with people and helping them make changes in their lives that really makes my day. Once we stop viewing patterns as "problems" to "eradicate" and simply discover fresh ways to meet the needs underneath those patterns, we eliminate many of our blocks to success and happiness. And isn't that what coaching is all about?

Wednesday, June 11, 2008

* Intraday Sentiment - Here's a look at the equity put/call ratio on a five minute basis (bottom chart) and a comparable chart for the ES futures (top chart). Put buying expanded early in the morning, but prices held above their overnight lows, suggesting underlying strength. Note also the dramatic expansion of put buying relative to calls around 1 PM CT, after the market had been selling off. This was a nice tell for profit taking on the short side, as price stopped moving lower despite increasing bearishness. Looking at option volume intraday provides a nice window on very short-term speculative sentiment.

* A Little Somethin' Somethin' - The Twitter Trader feature is really a blog within the TraderFeed blog, providing links to articles on market-moving themes, summarizing indicator data, and providing heads up on the day's major economic reports. I notice over 500 traders now subscribe; here's the page for free subscription. In honor of the 500 milestone, note that I posted one of the historical trading patterns in a Twitter "tweet" yesterday. I'll be doing a little more of that going forward, as not every pattern that I observe merits its own separate blog post. The last five "tweets" appear on the blog site under "Twitter Trader".

* Forex Expo - One of my rare public appearances will occur in September, at the Forex Trading Expo in Las Vegas. I was impressed by the organizer's insistence that the presentations be non-commercial and informative. My presentation will provide a window on some of the new material covered in the book I'm currently writing.

* Coaching Questions - I'm getting an increasing number of emails from traders asking coaching questions (i.e., requests for advice re: trading problems). Alas, I can't respond to all those emails, but I will be selecting a few related topics to address in blog posts in the next couple of days in hopes of helping as many traders as possible..

* Money Flowing Out of Financials - The above chart shows new price lows in the S&P 500 financial sector (XLF), as we see lower peaks in four-day money flows over the past few months. Note how flows have largely stayed below the blue zero line, indicating more money coming out of the sector than flowing in. Weakness in this sector has been an excellent tell for daily market direction in the large cap index.

Monday, June 09, 2008

Last week's indicator review emphasized a lack of buyer interest manifesting itself across a variety of measures. Particularly noteworthy were weakness in money flows and in the Cumulative NYSE TICK. That lack of interest translated into further price weakness this past week, as the S&P 500 Index ($SPX) moved to multi-week lows.

On Friday, we had 402 new 65-day highs across all NYSE, NASDAQ, and ASE issues against 360 new lows (top chart). The latter is the highest level of new lows since mid-April. A similar picture can be seen among fresh 20-day lows across the exchanges. Friday recorded 642 new 20-day highs against 1242 new lows. That is the highest level of new 20-day lows since March 20th.

This weakness has hit a majority of stock market sectors. Only the energy sector of the S&P 500 Index continues to register positive values in my Technical Strength index of trending. Among the 40 stocks in my basket, evenly drawn from eight S&P 500 sectors, we have as of Friday 7 stocks in uptrends, 4 neutral, and 29 in downtrends. Only 43% of S&P 500 stocks are now trading above their 50-day moving averages, down from 80% at the market peak. Only 29% of those stocks are now trading above their 20-day moving averages.

Despite this weakness, we are not yet recording significant oversold levels in my Cumulative Demand-Supply Index (middle chart), though the index has been deteriorating for a while. Readings below -20 have tended to accompany good intermediate-term buying opportunities; the current reading is -4.69.

Money flows for the Dow 30 industrial stocks (bottom chart) remain negative, with the four-day average continuing below the zero line. That means that more dollars are flowing out of those stocks than coming in. Interestingly, money flows during the last few days of weakness have not been as negative as seen a couple of weeks ago, but this will only be an important factor for stocks if we start to see divergences in other measures, such as the new highs/lows.

In all, there's not much to be excited about for the bulls. A look at the sectors shows fresh bear market lows for banking stocks and homebuilder shares. These sectors are the equivalent of the tech stocks during the 2000-2003 downturn; it is difficult to imagine a sustained bull market with these leading the downside.

Sunday, June 08, 2008

One of the highlights of my recent swing through the Pacific Northwest has been a visit with Henry Carstens and his lovely family. In case you're not aware, Henry has quietly build a premiere website featuring his well-researched market forecasts; his guides to testing out trading ideas; and a wealth of trading ideas. What you don't find on his site is self-promotion; nor do you find his (thinly supported) opinions on politics, the economy, Federal Reserve policy, or the latest batch of government statistics. His site is not about *him*; it is about *ideas*. And that, of course, speaks volumes about him.

So why has Henry been successful over the eight or so years I've been privileged to know him, supporting himself and his family with his trading and system development? One reason that struck me early in our conversation is his emphasis on when to shut down his trading systems. He does not view his edge as a particular trading idea or system. Rather, his edge can be found in his ability to find fresh market patterns and build them into new trading ideas and systems.

This confidence in his ability enables him to accept with equanimity the fact that the performance of all such ideas rises and falls, with many systems possessing a limited shelf life. Markets change as their dominant participants change, and with those changes there is a kind of Darwinian process that renders some ideas extinct, while others flourish. The ability to stay on top of this evolutionary process is Henry's true edge.

But psychologically, Henry embraces the failure of his ideas. He is prepared--cognitively and emotionally--to turn off his systems when they no longer perform up to their historical norms. At the same time, he is always on the prowl for new ideas. In between friendly chit-chat, he was eager during our visit to talk about trading and what is making markets move.

Not all traders are system developers such as Henry. But all traders do need the ability to turn off their trading at some times. Perhaps it's a time of day when things are thin and slow; perhaps it's a period of greatly altered trend or volatility. The ability to turn off trading and refresh ideas is itself one's way of adapting to changing markets. The trading dinosaurs don't know how to turn it off. They either *need* to trade (for psychological and/or emotional reasons), or they haven't developed the competency to refresh their market views and trading approaches.

It is one of life's little paradoxes that the ability to shut down trading is what facilitates long-term trading success. But that success only occurs when the shut down period is accompanied by creativity: fresh looks at markets that allow for new strategies, new adaptations to emerging market patterns.

Saturday, June 07, 2008

A surprising number of traders I hear from and work with experience what might be called a performance roller-coaster. They make money for a while, then become sloppy and overly aggressive in their trading. This leads to harrowing and frustrating losses, which in turn force them to focus their efforts and resume trading well. Not infrequently, these traders experience several boom-and-bust cycles before they reach out to seek help.

The culprit in this scenario is overconfidence. Trading gains lead to heightened expectations, which in turn facilitate overtrading. These changed expectations, ironically, lead traders to change how they're trading right at the time they're trading at their best! Instead of being satisfied with their gains, they press to achieve more. This leads to crippling drawdowns, because they're trading most aggressively even as they've strayed from their best trading.

My recent post focused on the importance of self-management in trading. A very perceptive reader who had experienced some of these trading ups and downs wrote to me recently and described a scoring system that he implemented for his trading. The system gave him points each day based upon his preparation for the day, the quality of his trading ideas; his execution of those ideas; and his management of the trades. Instead of focusing on his P/L each day, he has been emphasizing keeping his trading score high. This has aided his consistency, and that has paid off in profitability.

Another savvy trader wrote to me and described how he used visualization techniques each day to convince himself that he was coming back from a drawdown--regardless where his actual equity curve stood. By mentally rehearsing this "coming back from drawdown" mode, he also kept the focus on the *process* of trading, resulting in his best and most consistent profitability to date.

That is the paradox at the heart of trading and many other performance activities. The goal is profitability, but the best practice is to not focus on the goal. By staying connected to the processes that lead to the goal, we maintain consistency in our expectations, mood, and outlook--and that pays off in consistent performance.

Friday, June 06, 2008

With Thursday's powerful rise, we had 809 stocks across the NYSE, NASDAQ, and ASE register fresh 65-day highs and 1257 record new 20-day highs. By contrast, we had 227 and 604 new lows, respectively. While these numbers are below peaks recorded a few weeks ago, they're a meaningful turnaround from recent weakness. Demand, a measure of strong upside momentum, closed at 163; Supply at 24. That indicates that the rise was broad, affecting the majority of issues. This is also reflected in the relative strength of the small caps, with the Russell 2000 futures hitting a post-March price high.

My technical strength measure is a method of quantifying price trending behavior over a short-to-intermediate term time frame. Here's how the S&P 500 sectors look at present in terms of technical strength:

What we can see is that, as a group, there's been a nice turnaround from recent lows, but we continue to see very mixed sector performance. The weakness in the materials sector and the restrained strength of the energy shares are particularly noteworthy, as commodities have been performance leaders of late.

Technology remains a performance leader, which is consistent with my recent findings on money flows. The big story, perhaps, remains financial shares, which continue to lag badly. We've seen many steps taken to stabilize vulnerable banks, and these have yet to translate into meaningful, sustained confidence in the sector. This remains a potential Achilles heel for the market's attempted recovery.

Thursday, June 05, 2008

The last post took an initial look at quality control in trading. This stemmed from my realization that even relatively disciplined traders (including myself) pursue markets with a level of standardization that would be unthinkably low in the business world. One of the factors that has made a Toyota, Starbucks, or McDonald's so successful is that quality is controlled, across people and settings, day after day and year after year. That requires an unusually high level of managerial planning and oversight.

Trading is often described as a business, and traders are encouraged to treat their trading as a business. Many writers talk about the importance of business planning in trading. But if traders are to truly treat their work in a businesslike fashion, they need more than planning. They need to serve as the managers of their businesses. The maintenance of quality is one important facet of that management.

If we think about trading in quality terms, we want to identify the inputs into trading decisions, the processes by which decisions are made, and the outputs from those decisions. Inputs can be defined by the information that we need to process to make our best decisions. Processes involve information processing itself, including our ability to maintain a mindset conducive to optimal decision making. The outputs from trading decisions include the orders that we place, our management of those positions, and the profits that accrue.

The first sign of quality control problems in trading is lack of consistency. Inconsistency of inputs reflects variability in our preparation: sometimes we're more prepared for trading--we've done more and better homework--than other times. Inconsistency can also be present in our trading processes: variability in our state of mind while trading and our following of rules. Inconsistency often first shows up in trading outputs: variability in profitability, but also variation in how we size trades and take profits and losses.

If a trader truly operated as a business, he or she would identify "best practices" and turn these into standard operating procedures, with careful managerial oversight to ensure that these procedures are followed. Few of us truly know our best practices, however. It is impossible to implement quality if we have not made ourselves objects of our own study.

It is important to be one's own trading coach, but successful sports teams need managers as well as coaches. Writing out a business plan is the easy part. Managing that plan over time and becoming as consistent as a Toyota: that's a challenge. More on this aspect of working on oneself to come shortly.

About Me

Author of The Psychology of Trading (Wiley, 2003), Enhancing Trader Performance (Wiley, 2006), The Daily Trading Coach (Wiley, 2009), and Trading Psychology 2.0 (Wiley, 2015) with an interest in using historical patterns in markets to find a trading edge. As a performance coach for portfolio managers and traders at financial organizations, I am also interested in performance enhancement among traders, drawing upon research from expert performers in various fields. I took a leave from blogging starting May, 2010 due to my role at a global macro hedge fund. Blogging resumed in February, 2014, along with regular posting to Twitter and StockTwits (@steenbab). I teach brief therapy as Clinical Associate Professor at SUNY Upstate in Syracuse, with a particular emphasis of solution-focused "therapies for the mentally well". Co-editor of The Art and Science of Brief Psychotherapies (American Psychiatric Press, 2012). I don't offer coaching for individual traders, but welcome questions and comments at steenbab at aol dot com.